# Depletion

## Definition

In financial accounting, depletion is used to capture the decline in a natural resource such as petroleum, timber, and minerals.  Natural resources subject to depletion can be identified by one of two features:

• The asset can be completely consumed
• The asset can only be replaced by nature

### Calculation

Depletion = Cost Basis for Resource x (Units Extracted or Harvested / Total Units)

### Explanation

In order to calculate depletion, the company must first determine the depletion base, or cost of the natural resource.  These costs generally fall into three categories:

• Cost to acquire the resource
• Cost to develop the resource
• Costs associated with exploration of the resource

There is considerable controversy surrounding the depletion base for oil and gas reserves, due to the difficulty in estimating recoverable reserves.

### Example

Timber Company owns 50,000 acres of harvestable trees, which were purchased for \$10,000,000.  The company clears 5,000 acres in year one.  The depletion deduction would be:

= \$10,000,000 x (5,000 / 50,000)
= \$10,000,000 x 0.10, or \$1,000,000

This example uses the cost depletion method of accounting, which is used by most companies.  Alternatively, a percentage depletion method can be used.